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[Analytics] India’s economic struggle started long before coronavirus

A cat strolls past closed shops lining Jalan Masjid India in Kuala Lumpur April 2, 2020. — Picture by Firdaus Latif. Sketched by the Pan Pacific Agency.

The coronavirus crisis may have played a key role in amplifying India’s economic woes but the Moody’s assessment makes it clear that the ratings downgrade comes due to India’s failure to effectively implement key reforms. Koustav Das specially for the India Today.

ndia’s economic struggle started long before the coronavirus crisis, contrary to the common perception that the virus was the reason behind recent growth hurdles faced by Asia’s third-largest economy.

One of the three major international ratings agencies, Moody’s Investors Service, downgraded India’s sovereign credit rating to the lowest investment grade, accompanied by a negative outlook on Monday.

India’s rating now stands just a notch above “junk” status after Moody’s downgraded the country’s ratings to Baa3 for the first time in over two decades, making it harder for the country to raise funds internationally.

Moody’s said its latest decision reflects its view that the country’s policymaking institutions will be “challenged in enacting and implementing policies which effectively mitigate the risks of a sustained period of relatively low growth”.

The ratings agency highlighted India’s troubled financial sector and the government’s weak fiscal position as key reasons behind the downgrade.

CORONAVIRUS IS JUST AN AMPLIFIER

When the government stopped short of giving direct cash support to the poor and vulnerable in the wake of coronavirus lockdown, it was speculated that it devised its special Covid-19 package to avoid a ratings downgrade.

However, Moody’s said coronavirus just amplified India’s economic struggle and is not the sole factor behind the current slowdown or the ratings downgrade.

“The negative outlook reflects dominant, mutually-reinforcing, downside risks from deeper stresses in the economy and financial system that could lead to more severe and prolonged erosion in fiscal strength than Moody’s currently projects,” a press release by the ratings agency said.

Explaining the rationale behind the downgrade, Moody’s mentioned that action taken by it was in context of the coronavirus pandemic, but not driven by the impact of the pandemic.

“While today’s action is taken in the context of the coronavirus pandemic, it was not driven by the impact of the pandemic. Rather, the pandemic amplifies vulnerabilities in India’s credit profile that were present and building prior to the shock, and which motivated the assignment of a negative outlook last year,” Moody’s said.

It went on to add that slow reform momentum and constrained policy effectiveness largely contributed to the fresh ratings downgrade.

“Slow reform momentum and constrained policy effectiveness have contributed to a prolonged period of slow growth, compared to India’s potential, that started before the pandemic and that Moody’s expects will continue well beyond it,” it said.

The analysis by Moody’s indicates that India’s economic pressure was gradually building well before the start of this year. Real GDP growth in India has fallen from a high of over 8 per cent in fiscal 2016-17 to 4.2 per cent in 2019-20.

It expects GDP growth to contract by 4 per cent in fiscal 2020 due to the coronavirus shock, following which a sharp recovery can be expected in 2021-22.

However, it fears that after a short period of recovery, India’s economy could face a prolonged period of slower growth relative to the country’s potential.

Some of the factors it cited to support its assessment are rising debt, further weakening of debt affordability and persistent stress in parts of the financial system, especially NBFCs.

DEEP, DARK TUNNEL AHEAD

The coronavirus crisis may have played a key role in amplifying India’s economic woes but the Moody’s assessment makes it clear that the ratings downgrade comes due to India’s failure to effectively implement key reforms.

India’s plans to boost long-term economic outlook through a series of measures may not reap desired results in comparison to what the country achieved in the past.

Moody’s cited persistent weak private sector investment, tepid job creation, and an impaired financial system behind its lacklustre growth prediction for India.

“A prolonged period of slower growth may dampen the pace of improvements in living standards that would help support sustained higher investment growth and consumption,” it said.

The ratings agency stated that the Rs 20.97 lakh crore Covid-19 package, which consists mostly of medium-term measures, is insufficient to restore real GDP growth rate to levels seen as of March 2017.

“Moody’s does not expect that these measures will durably restore real GDP growth to rates around 8 per cent, which had seemed within reach just a few years ago,” it said.

The stressed banking sector will further increase India’s economic struggle and the ratings agency does not expect credit crunch in the “undercapitalised financial sector” of India to resolve quickly.

It went on to say that subdued growth in future will also dent the banking system’s “incomplete resolution” of legacy non-performing assets and governance reforms.

Moody’s said it is likely to further weaken asset quality and the health of banks and NBFCs.

The fresh ratings downgrade by Moody’s is not just a blow to India’s plans to raise fresh capital but further indication that the country’s economy is likely to tread on a slow lane for an extended period of time.

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